Empirical Microeconomics in Changing Times: A Reflection on 50 Years of IFS Research

Since the publication of the Meade Report in 1978 and the establishment of the Fiscal Studies journal in 1979, IFS has been a world leader in the microeconomic analysis of tax policy. Here we document the growing importance of rigorous empirical analysis in our academic and policy research. We point to the expanding reach of IFS research outside the pure analysis of tax policy in the years following the Meade Report and the key role played by the ESRC Centre for the Microeconomic Analysis of Public Policy, established in 1991. This Centre provided the environment for long‐term research across a wide set of fields that has enabled IFS to stay ahead in the policy debate and maintain a leading position in academic research. The breadth and depth of work in tax policy as it impacted on individuals, on families, on the labour market, on firms, on innovation, on retirement, on capital markets and on government revenues are exemplified through the Mirrlees Review. The expansion of IFS research into a broader set of areas, including health, child development and human capital, is captured through the recent launch of the Deaton Review on the causes and consequences of inequality, covering a broad set of inequalities and the challenges they bring to society, to policy and to research.     

The Mirrlees Approach to the Theory of Economic Policy

This paper summarizes James Mirrlees' key contribution to the theory of tax policy. It argues that the Mirrlees approach of viewing government as being constrained by imperfect information has changed profoundly how we look at the normative public policy. In this view, asymmetric information provides the limit to redistribution by restricting the efficiency-equity trade-off. It leads to consideration of other policy instruments for relaxing incentive constraints and improving the efficiency of redistributive policies. Some of these instruments include quantity controls, in-kind transfers and public provision or mandating of insurance, things we observe in practice.     

Optimal Taxation: Merging Micro and Macro Approaches

This paper argues that the large body of research that follows Mirrlees approach to optimal taxation has been developing in two directions, referred to as the micro and macro literatures. We review the two literatures and argue that both deliver important insights that are often complementary to each other. We argue that merging the micro and macro approaches can prove beneficial to our understanding of the nature of efficient redistribution and social insurance and can deliver implementable policy recommendations.     

Corporate tax,capital structure,and the accessibility of bank loans: Evidence from China

In this paper, we investigate whether listed firms in China adjust their capital structure in response to an increase in the corporate tax rate. Although theories of capital structure suggest that corporate tax is an important determinant of capital structure, how exogenous changes of the tax rate affect firms’ leverage decisions has not been fully explored. We examine a unique circumstance in which the Chinese government increased the corporate tax rate of firms that had previously received local government tax rebates. The evidence indicates that these firms increased their leverage when the corporate tax rate increased. Further investigation suggests that the adjustment of leverage was mostly driven by firms with a high level of access to bank loans.     

Local tax rebates,corporate tax burdens,and firm migration: Evidence from China

Conflicts of interest between local governments and the central administration in China have yielded many local policies that only serve the interests of local governments. The policy of first levying and then rebating taxes is an example of how local governments eschew the national tax regulations to boost local economies rather than national interests. In 2001, the Chinese government announced the termination of local tax rebates, which had some expected outcomes. We find that local governments complied with the new tax policy even though it no longer allowed local governments to grant tax incentives. However, some companies found ways to avoid the greater tax burdens by moving their business registration locations to tax havens. We also find that firms controlled by local governments were less likely to change registration locations. Our study examines the national tax regulation in China and explores how tax rules influence company decisions. In addition, we show that non-tax incentives, such as local economic development, may also influence company decisions.     

Optimal fiscal policy under multiple equilibria

We study optimal fiscal policy in an economy where (i) search frictions create a coordination problem and generate multiple, Pareto-ranked equilibria and (ii) the government finances the provision of a public good by taxing market activity. The government must choose the tax rate before it knows which equilibrium will obtain, and therefore an important part of the problem is determining how the policy will affect the equilibrium selection process. We show that when the equilibrium selection rule is based on the concept of risk dominance, higher tax rates make coordination on the Pareto-superior outcome less likely. As a result, taking equilibrium-selection effects into account leads to a lower optimal tax rate.     

The role of political elites in income tax system design and tax fairness

Given the importance of fairness in the public acceptance of tax systems (Mirrlees et al., 2011), understanding the role of political elites in the tax design process and how this impacts fairness is important. In this paper, we use an interpretative approach to examine the design and ultimate rejection of the Kansas tax policy experiment that ran from May 2012 to June 2017. The central design element of this experiment was the fundamental disruption of the long-standing principle of horizontal equity (fairness), in which non-wage business income was relieved of income tax, while wage income was taxed. By interpreting this experiment through a Bourdieusian lens, we identify five key themes that are helpful in understanding income tax design, tax fairness, and the role played by political elites. Overall, we contribute to the literature by highlighting the way in which cultural capital may be used by political elites to reformulate groups of taxpayers in order to justify unequal treatment of equal taxpayers, which represents a violation of the notion of horizontal equity (fairness). We also highlight that although such violations of fairness in income tax system design may be sustainable in the short run, over the longer term, notions of fairness are so deeply embedded in the habitus of individual taxpayers that a return to the status quo is likely.     

Redistributive impact of indirect tax reforms: Greece, 1988–2002

This paper assesses the distributional impact of indirect taxes among Greek households between 1988 and 2002, a period that coincides with the introduction of significant reforms in the tax system due to EU membership. The highly differentiated indirect tax structure prevailing at the beginning of the period had distributional benefits over the more simplified 2002 tax structure. The overall inequality of the after‐tax welfare distribution has increased by 6–12½ per cent and changes in the indirect tax system seem to explain about half of this increase. The paper also applies a recent method of measuring the distributional impact of relative price changes caused by changes in tax rates of commodities (Newbery, 1995) and establishes that indirect tax reforms introduced since 1988 had an adverse impact on the distribution of purchasing power, which nevertheless seems to be very small.     

The Effective Tax Burden of Companies and of Highly Skilled Manpower: Tax Policy Strategies in a Globalised Economy*

Company taxes and taxes on highly skilled labour both influence the attractiveness of a particular region as a location for investment. We measure the effective tax burden on capital investment and on highly qualified labour in 33 locations across Europe and the United States. We then correlate both types of tax burden in order to study the different tax policy strategies applied in different countries. We find that effective tax rates on companies and on highly skilled employees are closely correlated for a number of countries. Ireland and most new EU Member States impose relatively lower taxes on capital investment than on highly skilled manpower. Conversely, in the US, companies are taxed heavily but the effective tax rate on highly skilled employees is moderate.     

Fighting Tax Evasion by Discouraging the Use of Cash?

We propose a bargaining model of tax evasion with a seller that offers a price discount to a buyer in exchange for a cash payment without a receipt, which allows tax evasion. We study the effect on evasion and government revenue of two policy instruments: a tax on cash withdrawals (TCW), which imposes a cost on the buyers who pay cash, and a tax rebate conditional on having the receipt. The tax rebate reduces evasion but it is costly if tax evasion is low. The TCW reduces evasion only if it is set at a sufficiently high rate, which must be higher the larger is the mass of cash users. We also show that the implementation of a TCW, which poses several challenges, is easier if the cost of cash hoarding is high.     

Commitment and the time structure of taxation of foreign direct investment

The paper examines the role of commitment to future tax policy as an explanation for tax incentives for foreign direct investment that take the form of rates that increase over time. Both commitment and non-commitment to future tax rates are analyzed using a two-period model with investment determined endogenously in the first period. Without commitment, it is shown that tax rates may increase or decrease with time depending on the relative values of the firms' outside option each period of investing elsewhere in the world and on the responsiveness of investment to a change in the tax rate. With commitment, the time structure of tax rates is shown to depend on the relative rates at which firms and governments discount the future.This is a revised version of a chapter of my Ph.D. dissertation completed at Queen's University (1993). I am grateful to my supervisors Robin Boadway and Beverly Lapham for comments on an earlier version. I also thank Sam Bucovetsky and two anonymous referees for comments and suggestions.     

Banks as Tax Planning Intermediaries

We provide the first large‐scale empirical evidence of banks functioning as tax planning intermediaries. We posit that some banks specialize in assisting corporate clients with tax planning. In this role, banks make use of their centrality in financial relationships; access to private information; and ability to structure, execute, and participate in tax planning transactions for clients. We measure bank‐client relationships using loan contracts and measure client tax planning using either the cash effective tax rate or the unrecognized tax benefit balance. Using a difference‐in‐differences design, we find that firms experience meaningful tax reductions when they begin a relationship with a bank whose existing clients engage in above‐median tax planning. The effects of pairing with such tax intermediary banks are concentrated in relationships with larger or longer maturity loans, clients with foreign income or greater credit risk, and when the bank is an industry specialist or has above‐median investment banking activities. Finally, we find that potential clients are more likely to choose tax intermediary banks than nontax intermediary banks, suggesting that tax intermediary banks benefit by attracting new business. Collectively, our results suggest that some banks act as tax planning intermediaries, a role beyond the traditional one of financial intermediary.     

How Should Business Profit Be Taxed? Some Thoughts on Conceptual Developments During the Lifetime of the IFS*

This paper reviews developments since the 1970s in economic thinking about the design of taxes on business profit. It charts developments from proposals for a cash flow tax from the Meade Committee, to refinements of this in the form of an ‘Allowance for Corporate Equity’ and the levying of the cash flow tax in the country of destination. It describes how the development of international trade and investment has led to ever‐increasing problems in the international tax system with respect to economic efficiency, profit shifting, complexity and tax competition. It also identifies why a response to these problems requires a major reform in the location of taxation.     

Debt,Taxes, and Banks

Understanding the impact on banks’ capital structures of tax biases toward debt finance is critical to assessing policy responses to socially excessive bank leverage—but there is no empirical evidence of its extent. Guided by some simple theory, this paper explores this impact for a large panel of banks in 82 countries. On average, the tax sensitivity of banks’ leverage proves significant and about as large as for nonfinancial firms. Somewhat counterintuitively, but as the theory suggests, taxation has little impact on the use of hybrids. Banks holding smaller equity buffers and larger banks are noticeably less sensitive to tax.     

Compliance costs for personal income tax in a transition country: the case of Slovenia

The evaluation of taxpayers' compliance costs has grown in significance within tax system research over the last 15 years. In 2001, two surveys of VAT and personal income taxpayers were conducted in Slovenia to evaluate compliance costs for the 2000 fiscal year. This paper presents the results of research into compliance costs for personal income tax in Slovenia. The results show that compliance costs for personal income tax are relatively low, primarily because most taxpayers consider filing their tax declaration to be a simple procedure, which means that consultancy costs are low.     

Does Germany Collect Revenue from Taxing the Normal Return to Capital?*

A widespread objection to the introduction of consumption tax systems claims that this would lead to high tax revenue losses. This paper investigates the revenue effects of a consumption tax reform in Germany. Our results suggest that the revenue losses would be surprisingly low. We find a maximum revenue loss of 1.6 per cent of annual GDP. In some years, we even find tax revenue gains. This implies that the current tax system collects little revenue from taxing the normal return to capital. Based on these results, we calculate a macroeconomic measure of the effective tax rate on capital income.     

On the optimal timing of capital taxes

For many kinds of capital, depreciation rates change systematically with the age of the capital. Consider an example that captures essential aspects of human capital, both regarding its accumulation and its depreciation: a worker obtains knowledge in period 0, then uses this knowledge in production in periods 1 and 2, and thereafter retires. Here, depreciation accelerates: it occurs at a 100% rate after period 2, and at a lower (perhaps zero) rate before that. The present paper analyzes the implications of non-constant depreciation rates for the optimal timing of taxes on capital income. The main finding is that under natural assumptions, the path of tax rates over time must be oscillatory. Oscillatory tax rates are optimal when depreciation rates accelerate with the age of the capital (as in the above example), and provided that the government can commit to the path of future tax rates but cannot apply different tax rates in a given year to different vintages of capital.     

Taxation and Income Distribution Dynamics in a Neoclassical Growth Model

We examine how changes in tax policies affect the dynamics of the distributions of wealth and income in a Ramsey model in which agents differ in their initial capital endowments. The endogeneity of the labor supply plays a crucial role, as tax changes that affect hours of work will affect the distribution of wealth and income, reinforcing or offsetting the direct redistributive impact of taxes. We consider different ways of financing government expenditure and find that policies that reduce the labor supply are associated with lower output but also with a more equal distribution of after‐tax income. We illustrate these effects by examining the impact of recent tax changes observed in the United States and in European economies.     

Disability insurance and optimal income taxation

This paper studies the design of disability insurance scheme when agents differ in their privately known productivity. We extend the Diamond and Mirrlees (1978) two period model to allow for agents differing ex-ante in their productivity and characterize the optimal nonlinear tax transfer that maximizes a utilitarian welfare function when per-period earnings and age are observable while individuals’ productivity and health status are not observable. We show that the induced tax/benefit scheme should exhibit a marginal income tax that decreases with age for some agents. A marginal subsidy on the young high productive income may be desirable. While the disability scheme always involves the old low productive agents to be indifferent between working and claiming disability benefits, this result is not always true for the old high productive agents. JEL Classification H55 · H23 · E62